Q2 2019 commentary: Good news, bad news, good news

The ups came early, when United States stock markets surged in April. Economic data was improving, and the U.S. looked like it was making progress on a few key trade deals.

May was … different. Most of that progress seemed to dry up. U.S. manufacturing firms stalled (more on that later) and the number of new jobs in May was 100,000 fewer than expected.

But by early June, markets were treating bad news like good news.

The market is shouting to the Fed to cut rates."

Why? Because weaker economic data made it more likely that the Federal Reserve (Fed)—the U.S. central bank—will lower interest rates sometime in 2019. “The market is shouting to the Fed to cut rates,” says Robin Anderson, senior economist with Principal Global Investors. “One weak jobs report isn’t enough to push the Fed into action, but we think the Fed may cut rates sometime this year—maybe as soon as their meeting in July.”

Why are lower interest rates good news? Lower rates mean that money is cheaper to borrow. For businesses, it could mean they’re more likely to take on debt to expand. For you, it might be more attractive to buy a house or make a big purchase like a boat or new car if rates are lower because you’d get more bang for your buck.

Back in the first quarter, markets jumped when the Fed announced that they wouldn’t be raising rates. So, an actual cut might spur another market rally. But don’t expect a smooth ride. “With the slow global growth we’re seeing,” Anderson says, “we think there’s still room for continued market volatility.”

Can weakness be a strength?

Part of the market’s bad reaction in the middle of the quarter came from weakness in U.S. manufacturers. These industrial firms are sitting on bigger piles of inventory, which makes the market nervous. When inventories build, demand from consumers isn’t up to the levels of what companies are producing.

“Too much inventory can lead to price discounting,” Anderson says. You might be seeing emails about “inventory liquidation sales” and “overstock discounts” at car lots or appliance stores. They’re lowering prices to clear out all those TVs and SUVs.

That can hurt a company’s profit margins (a weakness). But—as they say—the savings gets passed on to you, the consumer. That can be a strength for the economy because people buy more stuff when it’s on sale.

Anderson says consumers aren’t yet feeling the same weakness as manufacturers. “The labor market is fantastic and consumer sentiment is near cycle highs, reflecting that strength,” she says. Another benefit to the consumer is the lack of inflation, or the general rise in prices. That’s perhaps an impact of price discounting on inventories.

Where could the U.S. economy go from here? Anderson expects a delay in the pickup of U.S. growth, and thinks some mild inflation might be in store for 2020. Manufacturing will likely pick up later in the year as companies sell excess inventory. Tight labor markets and strong wage gains will likely push companies to raise prices.

The labor market is fantastic and consumer sentiment is near cycle highs, reflecting that strength."

So, is inflation bad? Should you be worried? Not necessarily. Mild inflation—say around 2% a year—can be good for an economy. Rising prices tend to make people want to buy things sooner rather than later. Why wait until next year to buy that new dishwasher when it’ll cost more? That creates more demand in the economy, which helps push businesses and the economy forward.

But even mild Inflation can be a concern for investors like you. Any increase in prices can eat away at retirement savings—if prices are going up, the dollar you save today won’t buy as much in 30 years.

You might find benefit if you include some investments that help combat inflation. Some types of bonds called Treasury Inflation-Protected Securities (TIPS) are adjusted regularly to compensate investors for the effects of inflation.

Investment options that invest in physical assets, such as real estate or commodities, might also help offset inflation’s effect.

What can you do?

Check back in with your retirement account.

With markets bouncing around in the last 3 months, check in to see how your investment mix have fared. Log in and look at your statement to see the change between March and June.

Are you ready for higher inflation?

Certain types of investments do better when inflation’s on the rise. When you look at your mix of investment options, some investments may have “inflation indexed” in their names. You may want to look for investment options that mention commodities or real estate. If you’re not sure how to adjust, your financial professional can help.

Make sure volatility hasn’t bumped your portfolio out of alignment.

With markets moving up and down, your balance between stocks, bonds, and other investments may have shifted, too. It could be the right time to ensure your allocations still match your long-term financial goals. Look at your latest statement to see if the mix of investments is still right for your risk tolerance. If not, you could move some money around to get back in balance.

The subject matter in this communication is educational only and provided with the understanding that Principal® is not rendering legal, accounting, investment advice or tax advice. You should consult with appropriate counsel or other advisors on all matters pertaining to legal, tax, investment or accounting obligations and requirements.

Investing involves risk, including possible loss of principal. Asset allocation and diversification do not ensure a profit or protect against a loss.

Fixed-income investments are subject to interest rate risk; as interest rates rise their value will decline.

Real Estate investment options are subject to investment and liquidity risk and other risks inherent in real estate such as those associated with general and local economic conditions. Property values can decline due to environmental and other reasons. In addition, fluctuation in interest rates can negatively impact the performance of real estate investment options.

The commentary represents the opinions of Principal Global Investors. It should not be considered investment advice. No forecast based on the opinions expressed can be guaranteed and may be subject to change without notice. No investment strategy, such as diversification, can guarantee profit or protect against loss.